Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

Sunday, March 25, 2018

Researching For Deductions

I was
skimming a Tax Court case that almost made me laugh out loud.

It initially
caught my attention because it involved a deduction for research costs.

The tax
surrounding research costs come in two flavors:

·What is deductible as research?

·And – perhaps more importantly – can
you get a tax credit for it?

Let’s talk this
time about the first question, which may not be what you anticipate. Here is an example:

You build a garage to store your business equipment. The garage’s
claim to fame is that it is built from natural fibers rather than bricks and
lumber. It is the Kon-Tiki of garages. Can you deduct the cost of the garage as
you build it?

At the end
of the day, you will have a building. Granted, it may be unusual, but it is
still a building. Can you deduct a building as you go along? Or do you have to
accumulate (and defer) the cost until the building is ready for use? And then
what - do you deduct the accumulated cost at that time or do you deduct the
cost over a period of years?

You will be
deducting the cost over a period of years, otherwise known as depreciation. You
self-constructed a long-lived asset, and the tax Code (barring the unusual) will
not let you deduct it immediately.

Let’s swing
back to research costs.

What if the
research costs result in a patent?

You have
legal rights for a period of years to intellectual property, and the patent may
be worth a fortune.

So we rephrase
the question: can you immediately deduct the research costs resulting in that
patent?

But CTG, you
say, the two are not the same. Chances are that salaries make-up most of the
research costs. It doesn’t seem right to capitalize and depreciate salaries.
Sticks and bricks have staying power; they last for years. It makes more sense
to depreciate those rather than salaries.

Hmmm. What
about the wages of the tradesmen-and-women that constructed the building? Do we
get to carve those out from the sticks-and-bricks and deduct them immediately?

Of course
not.

You now get
the issue with research costs.

To answer it
the tax Code gives us Section 174:

(a) Treatment as expenses.

(1) In
general.

A taxpayer may treat research or experimental expenditures which
are paid or incurred by him during the taxable year in connection with his
trade or business as expenses which are not chargeable to capital account. The
expenditures so treated shall be allowed as a deduction.

As long as the costs meet the
definition of “research or experimental expenditures,” you have the option of
deducting them immediately.

Problem solved.

Our case this time is Bradley and
Hayes-Hunter v Commissioner.

Mr. Bradley
was a litigation consultant. He reviewed evidence, provided expert testimony
and conducted legal research. He was self-employed, and on his 2014 individual
income tax return he deducted $25,000 as “Research.”

The IRS was
curious what “research and experimental expenditures” a litigation coach could
possibly have. It is well-trod ground that Section 174 addresses research in an
“experimental” or “laboratory” sense. While one does not have to be in a Pfizer
lab wearing a white coat, one likewise cannot be in a library shepardizing law cases.

What did he
deduct?

I will give
you a clue: his billing rate was $250 per hour.

He deducted
$25,000.

And $25,000
divided by $250 is 100 hours.

Not only was
he nowhere near a Section 174 research cost, he was also deducting his own
time.

How I wish.

Who knows how
much tax research I do over an average year. If I could only deduct my time, I
would never pay income taxes again.

About Me

Thirty years years in tax practice. It's a long time, and I have seen virtually everything short of the fabled tax-exempt unicorn. I was raised in Tampa, went to school in Missouri, taught at Eastern Kentucky University, lived in Georgia, got pulled to Cincinnati when I married, have in-laws in England and a daughter going to the University of Tennessee. I am not sure where I will wind up next, but I hope there is better weather.